Venture Capital and Angel Financing For Universidad Adolfo Ibaсez

1
Venture Capital and Angel FinancingFor
Universidad Adolfo Ibañez

• John C. Edmunds
• February 1, 2006

2
Starting a New Business in the United States

• The founders develop a business plan.
• Then they create a corporation.
• They do not try to keep 51 of the shares.
• They do not plan on keeping the company and
  passing it to their children.
• Many founders are serial entrepreneurs which
  means they start one new business after another.

3
Starting a New Business in the United States, 2

• Many times the founders fail in their first
  attempt.
• Some also fail in their second attempt.
• The bankruptcy law in the United States is
  intentionally designed to allow founders a second
  or a third chance.

4
Starting a New Business in the United States, 3

• A person who has tried to start a business and
  failed is still a respected member of the
  community. He or she is not stigmatized for life
  and can still be successful later in another new
  business or in some other career.

5
Angel Financing in the United States

• After the founders of a new business have sold
  some shares in their company to family and
  friends, they sometimes find an angel investor.
• An angel is a rich person who helps the new
  company in its very early stage.
• The angel invests money and also offers advice.

6
Angel Financing in the United States, 2

• The angel usually invests an amount in the
  50,000 - 250,000 range and usually gets around
  20 of the shares of the new company.
• The angel tries to help the new company achieve
  enough growth to attract the attention of other
  investors.

7
Stages of Venture Financing

• Friends, Family and Fools
• Angel Financing
• Early Stage Venture Capital Financing
• Additional Round(s) of Venture Capital Financing
• Initial Public Offering of Shares OR Sale of the
  Entire Company to a Bigger Company

8
Venture Capital Financing in the United States

• There are many venture capital firms in the
  United States.
• A large number of them are around here in
  Boston or on Route 128 (also known as the Silicon
  Necklace).
• Most venture capital firms are small. They have
  a small number of officers.

9
Venture Capital Financing in the United States, 2

• The typical venture capital firm raises an amount
  of money in the 100 million - 500 million
  range. The money is put in by backers who
  agree to leave the money in the hands of the
  venture capitalists for eight years.
• After eight years the fund is liquidated. The
  backers recover their investment and their
  profit if the investments have been successful.

10
Venture Capital Financing in the United States, 3

• Most venture capital firms raise money from
  backers more than once. They start a second fund
  after two or three years, and then a third one.
• Venture capital firms can be so successful that
  they attract more capital than they can invest.
  This happened in 1999-2000 and might be happening
  now.

11
Venture Capital Financing in the United States, 4

• The rate of return that backers have earned from
  their investments in venture capital has been
  HIGH and VIOLENTLY CYCLICAL.
• This has been true for the entire history of
  venture capital in the United States.

12
Obtaining Venture Capital Financing in the United
States

• The founders of the new company try to pitch
  their company to venture capitalists.
• When they get a chance to make their presentation
  to a venture capital firm, they try to
  communicate how good their idea is and how
  successful their company will be.

13
Obtaining Venture Capital Financing in the United
States, 2

• If the key decision makers at the venture capital
  firm are interested, the negotiations begin.
• The founders of the new business try to get as
  much money as they need, while giving up as few
  shares as possible.

14
Obtaining Venture Capital Financing in the United
States, 3

• The founders typically give the venture
  capitalist 20 - 40 of the shares in exchange
  for 2 million to 5 million.
• The terms depend on how promising the company is,
  how good the management team is, and how many
  other venture capital firms are likely to be
  interested in financing the company.

15
Obtaining Venture Capital Financing in the United
States, 4

• The founders try to give the venture capitalist
  as few shares as possible because later the
  company might need to seek a second round of
  venture capital financing, or a third round.
• There have been successful companies that
  obtained as many as seven rounds of financing
  from venture capitalists.

16
Liquidity Events

• After the new company has been operating for a
  couple of years, the venture capitalists want to
  recover their investment and their profit.
• The opportunity comes when the new company makes
  an initial public offering of common stock.
  (IPO)

17
Liquidity Events, 2

• The IPO is the glamour moment in the life of a
  U.S. entrepreneur.
• The new company hires an investment bank to sell
  some of the shares, usually 15 or 20 of the
  total, to the public.
• The founders and the investment bankers do a
  road show to sell the shares that are being
  offered.

18
Liquidity Events, 3

• The shares that are offered to the public in the
  IPO come from three sources some come from the
  VCs, some come from the founders, and some are
  newly issued shares.
• That is so that the VCs recover their cash and
  some of their profit, the founders get rich, and
  the company gets some cash to finance its growth.
  

19
Liquidity Events, 4

• The shares of the new company are listed on the
  NASDAQ and the price of the shares sometimes
  rises very rapidly.
• The investment bankers set the initial offering
  price of the shares and also try to maintain an
  orderly market in the shares for a few months.

20
Liquidity Events, 5

• Sometimes the market price of the new companys
  shares rises to an extreme level on the first day
  of trading.
• This happened often during the period 1998-2000.
• The Google IPO (2004) used an auction process to
  limit the frenzy. Huge opening-day price rises
  are now much less frequent.

21
Liquidity Events, 6

• In reality, not very many new companies make an
  initial public offering of shares. Instead a big
  company buys them before they go public.
• The venture capital firms make huge profits
  whenever there is a liquidity event.
• They need the big profits to compensate for the
  (many) failures.

22
Venture Capital in Chile

• Hay, pero no hay.
• For the past few years, my Chilean friends have
  been VERY pessimistic about the possibility of
  obtaining venture capital financing in Chile.
• They tell me that the chances were better in 1996
  than in 2006. There is some hope for 2007.

23
Venture Capital in Chile, 2

• Lets discuss why people like you have had such
  difficulty obtaining venture capital financing in
  Chile.
• The size of the venture capital sector in Chile
  is, in proportional terms, about the same size as
  the venture capital sector in the United States.

24
Venture Capital in Chile, 3

• In Chile, venture capital funds have cash, but
  they do not place it.
• Instead the venture capitalists sit in their
  offices and reject the proposals they receive.
• Is that true? My Chilean friends think so.
• If that is true, why is it true?

25
The Conventional Explanation

• For 15 years I have been hearing an explanation
  why venture capital funds in Chile have been such
  a disappointment.
• The explanation has never convinced me but is has
  always convinced my Chilean friends.

26
The Conventional Explanation, 2

• Chileans are self-critical. Chilean venture
  capitalists say that they proposal they see are
  not worthy of financing.
• The Chilean economy is small, but is it REALLY
  too small to support new companies???

27
My Objection to the Conventional Explanation

• The conventional explanation assumes that Chile,
  as a country, suffers from some disadvantages
  that are impossible to overcome.
• It assumes that a business that starts in Chile,
  or operates entirely in Chile, can never be very
  exciting or valuable.

28
My Objection, 2

• I ask my Chilean friends if it is really
  necessary for Chileans to go to Silicon Valley or
  to Boston in order to have a good idea.
• Many of them think that Chileans become more
  creative after they leave Chile.

29
My Explanation for the Lack of Venture Capital
Financing in Chile

• Venture capitalists make mistakes.
• Two thirds of the ventures they finance fail.
• The key question is how much profit venture
  capitalists make on the investments that succeed.

30
My Explanation, 2

• In Chile, the venture capitalists were criticized
  for the mistakes they make in the Nineties.
• The venture capitalists had some successful
  investments.
• But on those successful investments they didnt
  make big enough profits.

31
My Explanation, 3

• The biggest profit I heard about was an
  investment where the venture capitalist made a
  return equal to six times the investment.
• That is not a big enough return to compensate for
  the failures.

32
My Explanation, 4

• The result has been that the rate of return on
  venture capital investments in Chile has been too
  low to compensate for the risk.
• This fact has made Chilean venture capitalists
  look bad.

33
My Explanation, 5

• Chiles capital markets were not set up to
  finance new ventures.
• The law allowing venture capital funds to be
  created was passed in 1989, BUT the other needed
  changes in the DESIGN of the capital markets did
  not come until a decade later.

34
My Explanation, 6

• During the Nineties there was no market for
  initial public offerings of common stock in
  Chile.
• La Ley de OPAS (1999) changed the treatment of
  minority shareholders.
• La Ley de Multifondos (2002) is what finally
  reactivated the Chilean stock market.

35
My Explanation, 7

• In 2004 and 2005 there were several initial
  public offerings in Chile.
• Two of these were oversubscribed in the ratio of
  17 to 1.
• The Chilean stock market is now functioning
  better.

36
My Explanation, 8

• The Bolsa Emergente IPOs in the years 2004-2006
  have not been Compañías Emergentes. The IPOs have
  been done by companies that are already mature,
  like Ripley, and also one semi-bankrupt football
  club (Colo Colo).

37
My Explanation, 9

• The Chilean venture capital funds are still being
  ultra-cautious because there STILL has not been
  an initial public offering of common shares from
  a company that obtained venture capital
  financing.

38
My Explanation, 10

• The venture capital sector in Chile needs a BIG
  success, something like Google.
• A Chilean venture capitalist needs to make a HUGE
  return, at least 100 for 1.
• Then the Chilean venture capital sector will
  become very vibrant and will give financing to
  all of you.

39
Future Prospects for Venture Capital in Chile
2007 -

• The government assigned US 200 million to CORFO
  in November 2006.
• The Initial Public Offerings via the Bolsa
  Emergente are continuing in 2007.
• Soon there will be an IPO in Chile by a company
  that received venture capital financing.

40
Future Prospects, 2

• Chile has fallen behind Brazil in IPO financing.
• Brazil, via the Novo Mercado, has done MANY more
  IPOs than Chile since 2004.
• Chile will take steps to catch up with Brazil in
  the key area of financing new businesses.

41
Conclusion

• In the U.S., the culture, the legal system, AND
  the financial system are all very friendly to
  entrepreneurs.
• Venture capital firms are profitable and
  sometimes very profitable.
• Many young people with ideas get financing.

42
Conclusion, 2

• In the U.S., there are periods of time when every
  start-up company gets financing, including the
  ones that so bad they should not get financing.
• The U.S. is in a period of time like that now.
• The next boom here has already started.

43
Conclusion, 3

• In Chile, there have been venture capital funds
  since 1990. Many start-up companies have
  received financing.
• The venture capital funds have performed poorly,
  especially since 1997.
• The Ley de Multifondos and the Ley de Ahorro
  Previsional have revived the demand of initial
  public offerings.

44
Conclusion, 4

• The preconditions are in place for venture
  capital in Chile to enter a phase of rapid
  growth.
• There have been several encouraging signs that
  key people in Chile now consider that venture
  capital is a priority.
• One more thing is needed a big success.

45
Conclusion, 5

• Capital will not flow to new businesses in Chile
  until there is a BIG success
• In which the venture capitalist obtains a return
  of 100 to 1 on the initial investment.
• This can happen soon in Chile because the initial
  public offering market has revived.